Tax Time & Joint Ventures: Landmines to Avoid
Having a great tax plan for your joint ventures means having a strong accounting system and regular application of the system to be effective. Before focusing on sending your co-venturer some financial details for the year-end reporting, we suggest asking yourself some questions.
Have you developed a plan for your accounting system?
This doesnt need to be complex or unique. Your system is more than just the acquisition of QuickBooks or a similar booking product.
What are you doing with the paperwork?
How is the information organized electronically?
Do you know how to interpret the details from the accounting reports?
Are you getting regular, meaningful reports from your accounting system and providing them to your co-venturers?
Getting the information to your co-venturers on a timely basis sounds easy, but in practice we see many struggle with this. As investors add more properties to their portfolios, without a systematic methodology to follow, a number of investors and property managers collapse. Great intentions, but inadequate execution appears to be the theme. Not taking the paperwork management part of the process seriously until too late causes investors and their co-venturers unnecessary stress and, often, unnecessary taxes.
Do you understand your legal agreement with your co-venturer?
Who pays for what, when are people reimbursed and how? What happens at the end? Is there an end? Make sure you have a clear understanding of your legal agreement and make sure you have one!
Who owns what?
This is important even between spouses. There are potentially negative implications to switching ownership percentages of properties around, or even changing the owners themselves. Further, if there are different legal and beneficial ownerships of a property (common in many joint ventures) these must be properly documented from a legal and tax perspective. This documentation provides support should authorities challenge the details.
Were currently involved with one messy audit where this is a particular problem and the CRA, in our mind, is being overly aggressive. While the prior accountant did not help, some additional coordination between the lawyer and accountant would have provided much more ammunition for the battle.
Changing the ownership also comes with risks. A couple of weeks ago a formerly silent shareholder for one of our clients asked that the reporting of dividends be changed for the past several years from himself personally to a corporation he owned on the advice of his accountant. I indicated that we were more than happy to make the change, as the primary shareholder had no problem with the change. But, we had to outline to his accountant some of the inconsistencies that would now exist between several years of tax returns, legal agreements and discussions, all of which would likely add up to a tax bill from the CRA for him personally.
Planning is great, but doesnt include backdating documents or recreating the past. Planning on a go forward basis avoids these types of problems.
Are you partners, shareholders, or co-venturers?
Each term has different legal and tax implications. Partners and co-venturers are the main problem as they are very difficult for even experienced professionals to differentiate. From a tax perspective, one of the biggest differences is that co-venturers are allowed to record their portion of the capital assets as their own, and take capital cost allowance (CCA – the tax equivalent to depreciation or amortization) independently of the other owners. This means they can tailor their claims to their particular tax situations. Partners, on the other hand, must agree upon (or are forced to accept) certain treatment.
Quick tip: One simple line in your legal documentation saying that you are not partners does not cut it!
Have you taken the time to structure your portfolio correctly from a tax and legal perspective, tailoring the plan to your situation and objectives?
When was the last time that your strategy was renewed and discussed with your lawyer and accountant? We strongly encourage a simple one hour planning or monitoring discussion once per year with our clients to ensure that, from a tax perspective, all is right in your corner of the world. The costs and implications of planning after the fact are often much more significant than planning in advance.
Complete tax planning before transactions occur is a much more effective strategy than cleaning up during a self-inflicted rush particularly where you are chasing down an awesome opportunity!
Your accountant will frequently be unable to commit significant planning time to you during March and April, so please plan accordingly. Planning does not need to always be super-complex, but can often result in significant savings and/or reductions in tax risk or penalties. Going overboard is expensive, but, similarly, going cheap can be expensive.
Have you agreed with your co-venturers on what will be considered capital (expensed over time or effectively at disposition) versus repairs or maintenance (expensed immediately)?
If you are both reporting on say 50% of a property, and have treated certain costs differently from each other, this is a red flag should the CRA compare your reporting. The CRA does not compare every tax report among co-venturers or partners, but make no mistake; this is certainly done on a test basis. Even worse, is finding out after the fact that one co-venturer has reported something as capital, then subsequently changed this to an expense by asking the CRA for an adjustment. While Im sure that there are cases where these are quite legitimate, I havent yet seen one go through successfully that I can recall. Further, it also frequently negatively affects the co-venturer since a red flag has been raised. This is an invitation to look back at prior claims. Essentially, capital vs. repair can be very subjective in the first place. Having your co-venturer indicate that they thought it was initially capital is quite the advantage for the CRA.
Are you aware that many costs are not deductible right away?
Some fees are supposed to be capitalized and written off over time, such as legal fees to acquire a property, fees with obtaining a mortgage or refinancing. A variety of costs may need to be capitalized if your property is vacant due to repairs. Many repairs or maintenance costs that would normally be deductible are supposed to be capitalized when incurred in the year of acquisition or disposition. Determining these amounts and reminding your co-venturer who may not be using a real estate-savvy accountant can help ensure consistent filing treatments.
Is it a good idea in your case to prepare your co-venturers personal tax filing forms (T776)?
There are certainly plusses and minuses. Consistent filing is great. In many cases the co-venturers or partners will have different amounts to report. For example, a common situation we see is one co-venturer advancing borrowed funds for the purchase, and wanting to deduct the cost of this interest. This interest expense is entirely theirs though and should not be split with their co-venturer.
Alternatively, the other co-venturer may be picking up some administrative costs, such as bookkeeping or property management fees, out of their portion of the earnings for which they may be 100% responsible.
In other words, some costs and revenues are shared between co-venturers and others are not. Specific spots on the tax forms provide for these common scenarios, but are often not disclosed to the co-venturers. Further, those using corporations do not require the use of the T776, particularly if there are different reporting periods which make using the T776 form of minimum benefit.
Are any of your properties located in the US or other foreign jurisdictions? Alternatively, are any of your co-venturers residing in the US or a citizen of the US?
If so, are you confident that you have ensured you have met both your Canadian and foreign tax requirements? Canada is very interested in all of the real estate you own, regardless of where it is located. Canada is very interested in your non-resident co-venturers and places additional tax reporting requirements and withholding taxes on them and in most cases YOU.
If your property is in the US, have you addressed your US reporting requirements? Have you addressed your Canadian filing requirements for foreign properties? Significant penalties exist for failing to address these issues. Successfully addressing the issues can differentiate you from your competitors and provide you additional, lucrative investment opportunities.
Are you working with a capable team?
Your real estate expertise is reflected in the team that you choose, and present, to your co-venturers. Look for fellow investors where a core portion of their business is dealing with real estate investors. You want to inspire confidence and ability compared to question marks and nervousness.
Do you have a relationship with your accounting team?
Are you simply using your accounting team as a commodity to complete tax returns and answer occasional questions? Or have you developed a relationship? Ensure you keep them updated with your plans, ask questions (knowing that some take time to answer), and communicate with them when things go right, and wrong. Relationships are a two-way street with your accounting team, just as with your co-venturers, and communication is key.
George Dube is a veteran real estate investor and Chartered Accountant whose practice with his partner Peter Cuttini, Dube & Cuttini Chartered Accountants LLP, focuses on providing the knowledge and tools clients from across the country, and around the world need, to increase and preserve the value of their businesses. George is a frequent guest speaker, addressing a variety of tax and accounting topics with implications for real estate investors.